How Brazil manages the challenges of industrial policy will define how much it fulfills its promise as one of the
The financial crisis of 2007-09 shook up the old hierarchy of economic power and ideas. It is likely to go down in history as a watershed moment for the dominance of western economic influence. It produced a remarkable moment in the globalisation process, where the rising economic powers like China, India and Brazil emerged among the winners and the advanced industrialised economies unexpectedly appeared the losers.
The crisis also challenged the conventional wisdom that had guided economic policy prescriptions for the past three decades. It saw a return of some old ideas (like Keynesian macroeconomics and theories of the developmental state), but this time with a new twist. There was a growing sense that the mainstream view could be legitimately challenged at a time when even the chief economist of the World Bank, Justin Lin, agreed that “in addition to an effective market mechanism, the government should play an active role in facilitating industrial upgrading and infrastructure improvements.”
It was in the context of these uncertain (but exciting) times that Brazil’s President Dilma Rousseff was sworn into office on 1 January 2011. Brazil’s rising global prominence presents its new government with opportunities to build on recent successes. Brazil has always adopted a nuanced and incremental approach to market-oriented reform never relinquishing the notion that the state must play a crucial role in the development process. However, shifts in the emerging global economic order made it difficult to define the appropriate path forward, although it allowed for creativity and flexibility in development policies. How Brazil manages the challenges of industrial policy will define opportunities for sustained and sustainable growth with social inclusion as well as shape its prospects for fulfilling its promise as one of the Brics.
Achievements and challenges
Beginning with President Fernando Henrique Cardoso (1995-2002) and accelerated under President Luiz Inácio Lula da Silva (2003-2010), Brazil achieved strong macroeconomic fundamentals and decreased poverty. Average growth in President Lula’s second term was 4.7% with his last year in office ending on a high note of over 7.5% economic growth and over 8% growth in domestic consumption. The number of poor fell from 30.4 million in 2003 to 17 million in 2010, while the numbers of the so-called middle class rose to 100 million (over 50% of the population). Moreover, for the first time in decades, Brazil was no longer among the top ten economies in terms of income inequality. A number of factors contributed to these achievements, including monetary stabilisation under the Real Plan, job creation as well as real and average wage increases, a booming stock market, and a variety of social policies (especially the conditional cash transfer programme, Bolsa Familia, which benefitted over 45 million Brazilians). Brazil’s international profile was rising, with growing exports (although share of its exports in global trade remained roughly at 1.2%), record levels of foreign direct investment (US$ 48 billion in 2010), and expanding operations of Brazilian companies abroad (most notably Vale, Petrobras and Gerdau).
The above positive trends do not imply that more of the same policy approaches will be enough. Many short and longer term challenges remain. There is an urgent need to redefine the macroeconomic policy mix in a context of growing inflationary pressures, a current account deficit, a strongly appreciating currency with a falling trade surplus, and high real interest rates. Among the longer term challenges are issues related to re-ordering public expenditure priorities (less on the bureaucracy and administration, but more for health, education and infrastructure), reforming taxes, reducing inefficient red tape and stemming opportunities for corruption, developing human capital and correcting the shortage of skilled labour, investing in physical infrastructure (especially transport and energy), and supporting a strong national innovation. Thus, although the problems are well known, Brazil faces a number of dilemmas in terms of how it should tackle them.
The role of the state
First, and perhaps at the crux of all debates about industrial policy, what should be the role of the state? There is general agreement that the state’s engagement must be of a qualitatively different nature than the earlier inwardly oriented import substitution period. Rather it should be focused on maintaining macroeconomic stability, provide a guiding vision for development, and be involved in an incremental process of steering and nudging firms to augment their competitiveness. Care should be taken not to get too involved in operational decisions or actual ownership of firms (it is worth registering a note of caution regarding the state’s mounting intervention in the oil and gas sector, specifically in Petrobras).
It is unclear whether the current government has a coordinated and well thought out strategy for Brazil’s development in the context of massive changes in the global economy. Opposition leaders have criticised the abundance of rhetoric in the ‘Lula era’, but have warned that concrete pragmatic actions are imperative for Brazil to advance. One of the key areas where the state could do more is to support innovation, although ultimately it is business that must take on its risks. Given its minimal spending on research and development (only1.2% of GDP in 2010), it places relatively low in innovation rankings (e.g. 68th in Insead’s). Clearly, Brazil must do more to build on its success stories, like Embraer (aircraft), Petrobras (oil and gas) and Embrapa (agriculture). Ironically, the very moment when Brazilian firms are becoming more innovative (38.6% are ranked as innovators), there is also a growing fear of deindustrialisation. The falling share of manufacturing in Brazilian GDP and exports have caused considerable concern, and it behoves the state to consider what its role should be in bolstering industrial activity and competitiveness.
Balancing the macroeconomic context
A second issue relates to defining the best approach to containing inflation. The new government is already grappling with the problems of getting the macroeconomic policy balance right. Brazilian business has felt increasingly disadvantaged by prohibitive interest rates, excessive tax burden and appreciating currency. Brazilian real interest rates are already very high making tighter monetary policy a less than efficient means of controlling inflation (even more so since elevated interest rates feed into the exchange rate further hurting firms’ competitiveness). It also raises the cost of capital and stifles much needed business investment (its investment rate has been below 20% for most of the past decade in comparison to over 45% in China). The fiscal policy option, specifically reducing government expenditure, might make sense in some areas, but should not be undertaken at the expense of education, health and social protection. Raising tax rates is even less feasible, given the already high tax burden (around 36% of GDP). Political opposition in Congress will make progress on the fiscal front piecemeal and unsatisfactory in the short-run, although the sooner it considers tax reform the better for business.
Investment and environmental policy
A third issue relates to how one can best raise the investment rate. Luiz Carlos Bresser Pereira, an economist and former Brazilian Minister of Finance, has quite correctly argued that one must distinguish between domestic savings and foreign borrowing as sources of investment funds for development. This is an issue that the new government should consider carefully. In addition, care should be taken when attracting foreign direct investment (FDI). Robert Wade and others have warned about the danger of multinationals creating import-intensive and deficit-prone industrialisation unless their investments are aimed at substantively adding value locally to feed into global supply chains. When FDI is market seeking, as often is the case in Brazil, it is even less likely to spontaneously develop desirable backward and forward linkages in the local economy. Witness how market liberalisation policies shrunk domestic auto parts firms’ share in total sectoral sales revenues from 47% in 1994 (pre-liberalisation) to 13% in 2005. The auto parts trade balance shifted from a US$ 912 million surplus in 1994 to a deficit of about US$ 2.5 billion in 2009.
A fourth area of concern relates to the priority to be given to environmental policy and “clean” product and production standards. While some industrialists see it as cumbersome and costly, this is a short term perspective. Not only are environmental concerns among local citizens as well as in international forums here to stay, but environmental exigencies should be viewed as an opportunity for innovation. Brazil could take a lead in building on its past achievements as well as developing competitive niches in new technologies for the future. For example, Brazil’s past response to the two “oil shocks” led to development of alternative fuels (mainly ethanol), which today contribute to its exceptionally clean energy matrix (46% of fuel used in Brazil is from renewable sources in comparison to 7.1% in the OECD and 12% in China). Moreover, its vehicle fuel profile made Brazil the obvious location for developing new automotive technologies such as flex fuel engines (which can accommodate a mix of up to four fuels).
Interacting with the global economy
On the external front, Brazilian industry also faces a number of immediate dilemmas with implications for industrial development and growth opportunities. First, Brazil needs to consider the question of its economic relations with China. Bilateral trade grew from just over US$ 2 billion in 2000 to over US$ 56 billion in 2010. While China is Brazil’s biggest client and trade partner, it was also one of its biggest competitors in both domestic and international markets. Brazilian imports from China were up 60% in 2010 and one in five firms imported inputs for their production process from China. However, the real tension lies in the fact that China looks to Brazil as a commodity exporter (food and minerals), but Brazilian imports from China have been in manufactures. Moreover, Brazilian manufactures have lost market share to China in international markets. The situation is made worse by Brazil’s growing frustration with China’s refusal to float or depreciate its currency, while the Brazilian floating exchange rate regime has seen its currency appreciating to the detriment of its export competitiveness. The China trade situation is exacerbated by the growing concern in some quarters about Brazil’s changing export profile. In 2009, for the first time since 1978, the share of manufactures in the total value of its exports fell below half, undermining Brazil’s pride in superseding its inherent comparative advantage in commodities.
Thus, the second dilemma related to Brazil’s insertion into the global economy, and subject of much debate in Brazil, is whether the government should resist reverting to becoming a commodity and natural resource based exporter, when experience suggests raising incomes and catching up with advanced economies requires relative success in higher technology production and exports. The more developmentalist-oriented policy community quite correctly urges the government to focus on the diversity and technological content of exports rather than absolute size of the surplus and total value of exports. Another dilemma related to the above issues was whether the nature of one’s export partners matters for development. Brazil was always keen to diversify trade partners, although in the past the advanced economies tended to account for about half of trade while the rest of the world accounted for the other half. This situation has changed, partly due to the growing share of China and partly due to shrinking demand in the advanced markets (especially the United States since 2008). The loss of the US is particularly sensitive issue for business, since the bulk of exports to that market had been manufactures.
President Rousseff must immediately deal with the above challenges and find a suitable framework for responding to the above dilemmas. Her government would do well to look to Brazil’s past industrial policy achievements and the lessons from East Asia’s successes to come up with a new strategy. The neo-structuralist approach developed in the Economic Commission for Latin America and the Caribbean (ECLAC) and theories of the developmental state provide a good starting point. The concentrated effort required for deepening industrialisation presumes a fit, responsive and efficient state. Moreover, it must work together with businesses and civil society to adopt technical advances, generate competitiveness, and produce the social cohesion necessary for sustained and sustainable growth with social equity. Only with a far-reaching social and political consensus will it achieve the desired transformation in its economic structure and social fabric.
Mahrukh Doctor is lecturer in political economy at the University of Hull